3 August 2023
About a year ago, in July 2022, we discussed activist investor’s (Elliott Management) position in shares of Pinterest.
Since then, shares returned 38% percent, compared to a 18% percent return in the S&P 500 Index.
Apart from activist investor’s position, we discussed the lessons from covid and recent post-covid periods. I believe the main lesson one should have learned is that we should base our decisions and actions on reality instead of religiously adhering to certain models or modes of thought.
Lessons of covid and post-covid periods
In 2020, even though the market was overwhelmed by the covid narrative, there was a positive side to all the chaos. A lot of noise, nonsense, conflicts of interest, and lies were washed away.
And reality started to shine brightly. Without covers, without camouflage, without anything that stands in-between us and life facts. The exercise of plain common sense, without the need for too much sophistication, would be enough to achieve good results.
While restaurants and hotels were closed, supermarkets were doing fine. While airlines and travel companies suffered, consumer goods packaging was in demand. While the banks’ performance became questionable, home improvement retailers such as Home Depot, Lowe’s, and Tractor Supply Company were enjoying increased demand for their products as people stayed at home.
Plain common sense, nothing more.
Fundamental, active investors willing to exercise plain common sense were in an excellent position.
However, they were not given the real chance to apply their (and Warren Buffett’s) wisdom.
A robust IPO market extended into 2021, while at the same time SPACs and tech “bubbles” continued.
Plus covid “themes” still took a large share of investors’ effort and focus.
Then the Ukraine came. And the oil price. And inflation. And the Fed. And S&P 500 Index declined 20% percent.
Activist investor investment in Pinterest
July 2022 announcement that an activist investor has built a stake in internet social media company Pinterest was a wake-up call to investors.
What this wake-up call meant is that investors would be much better off by addressing unfolding reality and that all the abstract discussions about inflation and the fed and interest rates and the oil price are only tools to comprehend part of the reality somehow.
To create meaning and achieve investment results, investors still need to play the role of a Fat Tony (familiar to us from Nassim Taleb’s books), exercise plain common-sense judgment, and take advantage of the unique opportunity to confront reality. Not only react passively to reality but influence and change it.
Activist investor investment in Colgate
In October 2022 it was revealed that Dan Loeb’s Third Point builds a stake in Colgate, and sees value in pet food business in a potential spin-off.
As per first quarter of 2023 SEC holdings disclosure, Colgate is Third Point’s largest position valued (at the end of the first quarter of 2023) at $830 million or 13.6% of total holdings value.
In the second quarter of 2023 investor letter of Third Point Limited, fund manager mentioned this (quote):
“…last October, Third Point correctly observed that markets bottom when economic data looks most bleak. Unfortunately, instead of expressing this constructive view by investing in high quality companies with earnings growth, Third Point committed capital primarily to value situations, which have underperformed this year…”
Event-driven value investing
History repeats itself. In 2021 IPO and SPAC bubbles continued, covid themes took away investors’ attention, then in 2022 war in Ukraine started, inflation theme unfolded, Fed raised interest rates, etc.
In 2023 the AI hype. The S&P 500 Index returned approximately 20% percent year-to-date while Third Point (as per Third Point Limited disclosures in the flagship Offshore Fund) returned approximately -1% percent.
Value investing is certainly not easy. Otherwise there would be 10 or 100 or a 1,000 Warren Buffets, not one (his shareholders back from 1950s don’t count).
However, I believe that a combination of value and an active approach will continue to provide investors with excellent returns in any market environment. The active approach could manifest itself either in the form of activist investor’s involvement or in the form of existing or possible events and catalysts.
Colgate
According to media reports, Loeb sees value in Colgate’s pet foods business “that could achieve a valuation of close to $20 billion on its 2023 numbers”.
Another story pointed out by hedge fund manager is that “consolidation in the consumer health sector points to more opportunities for Colgate”.
Colgate’s pet food business generated sales of $3.7 billion in FY 2022 and achieved an operating profit of $850 million. Estimating an EBITDA at $915 million means that a $20 billion valuation implies x21.86 EV/EBITDA multiple on FY 2022 results.
Colgate is currently valued at an EV/EBITDA valuation multiple of about x16.8 based on annualized H1 2023 results.
The sale or spin-off of the pet food segment at the valuation mentioned above might eliminate net debt completely and leave the company with additional net cash of approximately $12 billion (18% percent of current market capitalization). The overall amount of $20 billion represents 31% of current market capitalization, which is also a significant amount. If Colgate chooses to add additional leverage, it can unlock an additional amount of $5 billion (x1.5 on remaining EBITDA).
The separation or sale might create a situation where the remaining Oral, Personal and Home Care segments will become much more interesting from the pricing perspective. In an inflationary environment, at some point the price might rise significantly without damaging the demand.
Given all this, it seems that investment in Colgate provides investors with a conservative but attractive upside potential with risk-return skewed to the upside.